In business, asset disposal attracts either a gain or a loss. Since a cryptocurrency is a digital asset, it is subject to this same market principle. Therefore, as a crypto holder, you need to understand the concepts of these profits and losses to make objective market decisions.
So, how about we start from scratch?
What is a Capital Gain in Cryptocurrency?
A capital gain can be quantified by how much the value of an asset has increased at the point of sale. That is, every time you dispose your crypto asset at a value higher than the purchase value, you realise a capital gain. On the other hand, a capital loss works the same way; it occurs when a crypto asset holds a lower value at its disposal.
What are Realised and Unrealised Capital Gains in Cryptocurrency trading?
Capital gains (or losses) can be quantified before or after disposal. However, these gains are only real after the crypto assets have been sold. This tangibility (at the sale) is the basis for classifying capital gains as realised or unrealised.
A realised capital gain is the actual increase in asset value at the point of disposal. An unrealised capital gain also quantifies an increase in your crypto asset value, although prior to sale. In some contexts, unrealised capital gains are called paper or running profits.
For instance, if the value of your bitcoin at the time of acquisition is 3000 dollars and you dispose of it for 6000 dollars, the realised capital gain is 3000 dollars. If you hold the assets for two weeks and the current market value is at 4000 dollars, then the unrealised capital gain is a thousand dollars.
However, according to PWC, depending on how you dispose of your crypto assets, the concept of realised capital gains may not be necessary. For instance, capital gain calculations are irrelevant when crypto-assets are gifted out or donated to charity, according to Forbes(at least in most countries).
How to Calculate Capital Gains or Losses in Crypto?
Calculating capital gains or losses of crypto assets is simple. Here are three simple steps you need to follow:
- Find out the Cost Basis of your Asset – First, you need to know the total value attached to your asset at the point of purchase. According to CNBC, when calculating this, you need to consider not just the actual purchase price but also the othercosts incurred during acquisition. As a case in study, the transaction fee.
In case your crypto was gifted to you, you could use the fair market value of the currency at the time of acquisition. - Subtract the Cost Basis from the Current Value – To calculate realised capital gains, you subtract the cost basis (or the fair market value as the case may be) from the value of the asset at disposal. To calculate unrealised gains, on the other hand, you need to subtract the cost basis from the current market value of the asset.
Summarily, Unrealised Capital gain = Current Fair Market Value (FMV) – Fair Market Value (FMV) at purchase.
Realised Capital gain= Value at disposal – FMV at purchase/ cost basis, where FMV stands for fair market value. If the value is negative, it is a capital loss. If the value is positive, then you have a capital gain. - Multiply your total units by the gain – Multiply the loss or gain by the total quantity of assets you have to get your total capital gain or loss. For instance, if the capital gain per unit bitcoin is 1000 dollars, and you have five bitcoins, then your total capital gain is 5000 dollars' worth.
How Are Realised and Unrealised Capital Gains Taxed?
Realised capital gains are taxed differently with respect to individual country policy and the timeframe of asset ownership. They are classified into two based on the time frame of asset ownership. This classification is done for the purpose of taxation. Long-term capital gains are profits made on crypto assets that have been held for more than a period of 365 days.
For long-term capital gains, you are subject to paying a certain percentage in the tax rate, depending on your taxable income level. Short-term capital gains, on the other hand, are gains on digital assets held less than 365 days. These capital gains are taxed solely based on your income tax rate at an ordinary level.
NOTE: Long-term capital gains are taxed at 0%, 19%, 32.5%, 37%, and 45% respectively, depending on how much income you make. This rule applies to all investment assets, including crypto assets in Australia.
Finally, as a crypto asset holder, it is necessary to keep track of unrealised capital gains and capital losses. Depending on the tax policy of your country, you can use this information to reduce your taxable position. You can also use it to balance out your net capital gains against your profit. Let's examine how this works, shall we?
On the other hand, unrealised capital gains, unrealised capital losses, and realised capital losses don't attract tax fees under any circumstance.
How to Minimise Tax Payment on Crypto Capital Gains
To minimise the amount you will spend on capital gains tax, here are some things you can do:
- Invest your crypto assets through a retirement plan: You can avoid capital gains tax on your asset totally through this means.
- Offset your losses: You could balance out losses by disposing of underperforming assets. This will be explained in the later parts of this article.
- Hold your crypto assets for a long-term period: For instance, you could reduce the amount of capital gains tax in Australia by 50% if you own an asset for over a year. By implication, you are taxed on half of your asset net capital gain.
- Deduct mining expenses from your income: If your crypto acquisition method is through mining, you can deduct expenses like electricity, computer, and internet data charges. This significantly reduces your cost of capital gains and, subsequently, the capital gains tax.
- Sell your asset at a favourable time: Depending on how long you can hold your asset, you could time your sale to when tax payment will be minimal. For instance, a Professor, Jeff Hoopes, as quoted by Forbes, explained, "Perhaps you got laid off, retired, went back to school, or moved to a lower tax state. Then you might find yourself in a lower tax bracket, which would allow you to sell your crypto while owing less in taxes."
- Donate some of your assets to charity: This method would surely not add to your income, but it would reduce the total amount of capital gains tax you should pay for your crypto assets. It works in most countries of the world.
It is noteworthy to mention that it is impossible to totally avoid paying capital gain taxes as a crypto assets' holder. However, you are not liable to pay taxes as long as you hold on to your crypto asset.
What is the Importance of Unrealised Capital Gains?
As a profit-minded holder of a crypto asset, it is pertinent that you keep track of unrealised gains/losses and realised gains. These records help you achieve the following:
- Understand price fluctuations and market trends – Keeping a record of unrealised gains and losses gives you a general idea of how the price fluctuates in the crypto market. With this information, you can set up a profit/loss margin for yourself and make correct predictions of market trends. Finally, you can deduce enough to minimise the risks associated with your crypto investments.
- Make informed decisions on when to Hodl - These records help you determine how volatile the coin market is with relative ease. You will have insight into the possible risks of letting go of or holding on to your asset. That way, you can make informed decisions on whether to dispose of or #hodl your crypto assets.
- Offset losses and reduce tax expenses – Keeping records of unrealised gains (and losses) can help you offset your losses. The process of doing that is called tax-loss harvesting. In this process, you sell at a loss when underperforming assets show a sign of plummeting further against a high capital gain tax expense. This way, your losses are realised, and the tax burden is automatically cut down.
Conclusion
Having a thorough understanding of realised and unrealised capital gains and losses is important for any digital assets holder. First, they are the basis for understanding how cryptocurrencies work and how it affects your investment. Second, this knowledge is pertinent to making necessary and profitable decisions regarding your asset investment.
Furthermore, it is important for any crypto trader interested in paying their crypto taxes. Finally, the concept teaches that asset holders not only consider profits and losses while trading digital assets, but they should also consider tax balances too.
Do you have any question or seek advice on taxation and profits concerning cryptocurrencies? Please drop a message in the comment box. We are always available to answer them.
